Posted: June 30th, 2015

DISCLOSURE OF RISK AND RISK APPETITE IN UK BANKS INDUSTRY AND BUILDING SOCIETIES

I. Introduction

1.1. Background of the Study

Risk is a concept of “concern about the uncertain and random future”. For banks, risk is often about the resources, which can be defined as some types of risk they need to management, they are credit risk, market risk, liquidity risk, operational risk, compliance risk, and so on. A proper understanding on the concept of risk appetite could be used as a powerful tool in managing risks and enhancing the overall business performance. Organisations would be able to define the maximum risk tolerance threshold and developing action plans to mitigate the risks if it possesses standard measures in defining risk probabilities and the subsequent impact of risks to the business. The different between risk and risk appetite is that risk appetite is the organization choose even like to take the risk in order to get higher return, but not every organization like risk because it may cause lose.

The concept of risk appetite basically outlines the amount of risk that should be assumed by the organization in attempt to obtain its desired level of returns, which a company voluntarily accept the risk in order to gain the superior returns from the strategic, and many companies take the risks from their research and then develop activities. However, the concept is relatively difficult to attest in practice, since there are unclear definitions of risk appetite. Subsequently, Kumar and Persaud (2002) suggest that while this term had been widely used in various reporting schemes, there are still considerations and confusions related to the connotation of the term. Various accounting researches had also been attempting to assess and provide definitions on this variable. However, Bohn (2012) noticed that various efforts to quantify risk appetite had often creates a precision illusion instead. As precise measurements are not always possible and that the risk appetites are sometimes defined broadly, the quantification of risk appetite had been varied in different organisations. Hamilton and Micklethwait (2006) attributed this with the condition where some organisation may have greater appetite on a particular type of risk while maintaining averse attitude on other risks; depending on the context, as well as potential losses or gains from these risks. These orientations had also cause different measurements to be imposed to different risk categories, and this could be related to the overall risk attitude in the firm.

1.2. Research Objective and Research Questions

Motivated by these issues, this research would aim to develop a measurement standard to assess risk appetite in the firms and how the risk appetite would affect disclosure preferences in the firms. In particular, the subject of assessment would be focused in UK banks and building societies. Additionally, the assessment would also include the discussions and assessment of the industrial environment, which could also affect the risk preferences of the British banks and building societies, as well as their decision of disclosing this aspect in their financial reports. There are some differences between banks and societies. Building societies are mutual institutions, they are owned by customers not shareholders, mainly asset for house purchase, and the businesses are much more simple than banks. However, banks are owned by their shareholders, and they are more variety and complex transaction than building societies. Also, banks have higher risk. Particularly, this research would be focused in providing answers to the following research questions:

Whether the risk appetite could be quantified for British banks and building societies in UK?
How does risk appetite differ between banks and building societies?
To what extent does risk appetite subsequently affects risk disclosure decisions of the British banks and building societies?

II. Proposed Research Method

This study would apply the mixed research framework, combining both qualitative and quantitative research method. Primarily, quantitative research framework is adopted to assess the relationship between the risk and risk appetites of the banks against their subsequent risk disclosures.

The results of the statistical analyses would be subsequently discussed using qualitative research framework, where a comparative analyses is conducted between the findings from this research against findings and arguments from previous studies that would be summarised into the literature review segment. By applying this research concept, this study would be able to explain the similarities and disparities of the findings, while allowing the readers to obtain more comprehensive knowledge and understanding on the relationship between these aspects, and other factors that may have caused disclosure differences between firms in different industry.

In terms of data collection, this study shall be reliant on secondary data, where the risk and risk appetite information would be derived from the financial reports of the UK banks and building societies. These banks comprise as of including: HSBC, Lloyds Banking Group, Royal Bank of Scotland, Barclays, Standard Chartered, Santander, NatWest, and some other small local banks in UK. There are also five building societies in UK with current account, including Nationwide Building Society, Yorkshine Building Society, Coventry Building Society, Leeds Building Society, and Cumberland Building Society.

III. Literature Reviews

The choice of this dissertation topic was motivated by the iteration of Linsley and Shrives (2006) of which it was reported that most of the general risk management statements and policies of the UK companies are characterised with lack of coherence in risk narratives; indicating that there is a risk information gap that disallows shareholders to adequately assess the risk profile of the British company. Accordingly, Linsley and Shrives’ content analysis method would also be adopted into this research’s framework to assess the risk reporting of the British banks and building societies.

Secondly, this research is also motivated by the assessment of Miihkinen (2012) on the Finnish firms’ disclosure preferences, where there are no evidence suggesting that the application of governmental standards has no immediate impact to the substance of risk information provided by the firms, which could explains the hypothesis as of why the financial reports of British banks and building societies had been mostly criticised of being merely boilerplating, despite of more stringent reporting standard in the post-crisis environment (Abraham and Shrives, 2014), indicating that risk reporting could have been affected by other factors, such as the company risk appetite. Accordingly, this research also considers the opinion by Harner (2010), who suggest that peculiar industrial characteristics and current industrial outlook would have impacted the risk disclosure preferences of the company; indicating that risk appetite may have insignificant contribution to the reporting and disclosure scheme.

The selection of independent variable in this assessment is also influenced by the definitions of risk appetite measurements as postulated by Bohn (2012), who suggest that factors such as income, costs, impairment, market risks, operational risks and taxation burdens as a good indicator to test the foreboding risk appetite factors within the firm, and that for banking industry and building society, the inclusion of risk weighted assets might also be necessary.

IV. Expected Contributions

The conduct of this study is expected to provide deeper insight on the risk management mechanism in the banking industries and building societies, and providing the outline of risk disclosure in British banking and building societies sector for the investors. To some extent, this research is attempted to provide possible explanations as of why the British banks’ and building societies’ disclosure had been alleged to have boilerplating characteristics, if the hypothesis is true that their risk appetite could also affect their disclosure decisions.

V. Academic Sources

Abraham, S., & Shrives, P. J. (2014). Improving the relevance of risk factor disclosure in corporate annual reports. The British Accounting Review, 46(1), 91-107.

Bohn, J.R. (2012). Better Risk-Appetite Frameworks and More Risk Disclosure can Improve the Global Financial System`s Stability and Resilience

Hamilton, S., & Micklethwait, A. (2006). Greed and corporate failure. The Lessons from Recent.

Harner, M. M. (2010). Ignoring the Writing on the Wall: The Role of Enterprise Risk Management in the Economic Crisis. J. Bus. & Tech. L., 5, 45.

Kumar, M. S., & Persaud, A. (2002). Pure contagion and investors’ shifting risk appetite: analytical issues and empirical evidence. International Finance, 5(3), 401-436.

Linsley, P. M., & Shrives, P. J. (2006). Risk reporting: A study of risk disclosures in the annual reports of UK companies. The British Accounting Review, 38(4), 387-404.

Miihkinen, A. (2012). What drives quality of firm risk disclosure?: the impact of a national disclosure standard and reporting incentives under IFRS. The International Journal of Accounting, 47(4), 437-468.

Robert S. Kaplan & Anette Mikes. (2012). Managing Risks: A New Framework.

Santhosh Abraham & Paul Cox. (2007). Analysing the determinants of narrative risk information in UK FTSE 100 annual reports.

Ahmed Barakat & Khaled Hussainey. (2013). Bank governance, regulation, supervision, and risk reporting: Evidence from operational risk disclosures in European banks. International Review of Financial Analysis. 30, 254–273.

Philip M. Linsley & Michael J. Lawrence. (2005). Risk reporting by the largest UK companies: readability and lack of obfuscation.

Philip M. Linsley & Philip J. Shrives. (2005). Transparency and the disclosure of risk information in the banking sector.

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